For a Competitive Tax System, the U.S. Should Copy Estonia Rather than Italy October 15, 2020 by Dan Mitchell

 Whether we’re examining Economic Freedom of the World, Index of Economic Freedom, World Competitiveness Ranking, the Global Competitiveness Report, or the World Bank’s Doing Business, publications that endeavor to give us apples-to-apples comparisons of economic policy provide useful measuring sticks.

• We can learn how Hong Kong compares to Singapore.
• We can determine the freest nation in Latin America.
• We can find a bright spot in Africa.
• We can assess whether any European nation is avoiding statism.

I’m especially interested in comparisons that focus on fiscal policy.

So I was very interested to see that the Tax Foundation just released its annual International Tax Competitiveness Index, which measures the quality of tax policy of nations that are part of the Organization for Economic Cooperation and Development.

Here are highlights from the report, starting with some background.

The structure of a country’s tax code is an important determinant of its economic performance. A well-structured tax code is easy for taxpayers to comply with and can promote economic development… In contrast, poorly structured tax systems can be costly, distort economic decision-making, and harm domestic economies. Many countries have recognized this and have reformed their tax codes. Over the past few decades, marginal tax rates on corporate and individual income have declined significantly… Not all recent changes in tax policy among OECD countries have improved the structure of tax systems; some have made a negative impact. …The International Tax Competitiveness Index (ITCI) seeks to measure the extent to which a country’s tax system adheres to two important aspects of tax policy: competitiveness and neutrality. …To measure whether a country’s tax system is neutral and competitive, the ITCI looks at more than 40 tax policy variables. These variables measure not only the level of tax rates, but also how taxes are structured.

The ITCI is a very useful publication. Indeed, I’d like it to be expanded. When writing about last year’s edition, I mentioned it should cover more nations and also include the aggregate tax burden as one of the variables.

But let’s not make the perfect the enemy of the good. With regards to this year’s version, what nations have the best and worst tax regimes?

Estonia ranks #1 (not a big surprise) and Italy is at the bottom (also not a big surprise).

For the seventh year in a row, Estonia has the best tax code in the OECD. Its top score is driven by four positive features of its tax system. First, it has a 20 percent tax rate on corporate income that is only applied to distributed profits. Second, it has a flat 20 percent tax on individual income that does not apply to personal dividend income. Third, its property tax applies only to the value of land, rather than to the value of real property or capital. Finally, it has a territorial tax system… Italy has the least competitive tax system in the OECD. It has a wealth tax, a financial transaction tax, and an estate tax. Italy also has a high compliance burden associated with its individual tax system. It takes businesses an estimated 169 hours to comply with the individual income tax.

American readers presumably are most interested in the United States, so here’s the data showing that the United States has a mediocre grade, ranking #21 out of 36 nations.

If you dig through the details, the good news is that the United States has a very high score for “consumption taxes,” which largely is because we haven’t copied the mistake of other nations and imposed a value-added tax.

The U.S. also gets credit for “expensing,” though the report notes that policy is scheduled to expire.

The bad news, by contrast, is that America ranks below average for corporate taxes and individual taxes and way below average for property taxes and international tax rules.

The report also notes that America’s “progressive tax” is a weakness that undermines competitiveness.

But let’s look at the glass as being half full rather than half empty. When the Tax Foundation launched this publication back in 2014, the United States was a lowly #32 out of 34 nations. And we were still mired near the bottom in 2016, ranked #31 out of 35 countries.

Thanks to the Trump tax reform, however, the United States has subsequently enjoyed the biggest improvement of any nations. There’s still plenty of policy mistakes that need to be addressed, but at least we’re moving in the right direction.